Suppose that the economy is at full employment, the price level is 100, and the multiplier is 2.Investment increases by $10 billion.In the short run _______ , and in the long run _______ .

Question

Quizplus · Accepted Answer

Since the economy is at full employment, any increase in investment would lead to an increase in the price level. The equation for the short run impact is given by:
ΔY = [1/(1-MPC)]*ΔI
Where ΔY is the change in Real GDP, MPC is the Marginal Propensity to Consume, which is the proportion of the additional income that is spent, and ΔI is the change in investment. As the multiplier is 2, the MPC must be 0.5.

ΔY = [1/(1-0.5)]*10 billion = $20 billion

Therefore, in the short run, real GDP increases by less than $20 billion due to the increase in investment. However, in the long run, the increase in investment may lead to an increase in productivity, which would shift the aggregate supply curve to the right. This would increase real GDP further. However, as the question only asks for the short run and the long run effect is uncertain, option B is the best answer.

Suppose That the Economy Is at Full Employment, the Price